Turn America into a nation of savers

Smart policies could make savings, not consumption, the new norm.

November 9, 2009

By Reid Cramer

Washington

In pursuit of an economic recovery, President Obama has argued that we must transition from an "era of borrow-and-spend to one where we save and invest." It is an appealing concept, especially as the disappearance of surplus assets and historic levels of debt helped transform a garden-variety business cycle recession into a historic collapse.

But how does the saving and investing square with high levels of government borrowing and spending to stimulate the economy, protect those thrown out of work, and prop up consumer demand?

Isn't this a bit like a person who proposes to fatten up first so as to have the strength to lose the lard later?

There is a way to reconcile the competing short- and long-term needs of the economy, and also of our individual citizens. The key is increased personal savings. And with bold steps, we could make saving the norm for every American.

Individual households need access to savings as a security blanket to manage risk and make productive investments that can pay off down the line. Families without savings when the recession began had a more precarious hold on their own economic security. Increased savings will also drive the performance of the macroeconomy.

For the next few years, we should expect the federal government to continue to spend more than it takes in. This will be a good thing as it solves the troublesome "paradox of thrift," where reduced economic prosperity leads to sudden declines of consumer spending, which accounts for two-thirds of the economy.

But once the economy recovers, a high savings rate still will be essential to financing the investments American business must make to improve efficiency and avoid the looming prospect of inflation. And the more Americans of all classes save, the less dependent the country becomes on foreign creditors to buy our debt.

From the 1960s through the '80s, US households saved a healthy amount of disposable income – often more than 10 percent.

That rate started dropping in the 1990s, and by 2005 it was dangerously close to zero. Personal debt skyrocketed during this period, as rising home values and stocks gave people the feeling of greater wealth. When the recession took hold in 2008, it seemed that this problem might self-correct, since people spend less when faced with job loss or diminishing home assets. True to form, savings soared, topping off at 6.2 percent in May – the highest since 1995. Yet by August, the rate had fallen to a mere 3 percent.

That's a signal that we shouldn't assume a new, more responsible era has already dawned. The recession may have converted many Americans to thrift in the short term, but we shouldn't squander the opportunity to put in place protections that can help families weather future downturns and create a strong economy for the long term.

So, what can be done?

One approach is to take advantage of recent work in the field of behavioral economics, which has shown that saving works best when it happens automatically. Studies show that many more employees will participate in a 401(k) if they are automatically enrolled and given the choice to opt out than if they must make the affirmative effort to sign up themselves.

There is much promise in having savings deposits deducted from paychecks as a matter of course, as they are under 401(k) plans. Such a policy, call it AutoSave, would strategically build on inertia, which, it turns out, is one of the most powerful forces in the universe, along with compound interest. Unfortunately, only about half the workforce currently takes advantage of 401(k) plans with these automatic features, mainly because their employers do not offer them. The Obama administration has proposed remedying this by providing all workers access to a central clearinghouse of savings plans that they could access. It is certainly a step in the right direction, but we should also think more boldly.

What if, for example, the federal government established an account for every American, including children? These lifetime savings accounts could even be started at birth, so children would already have their own account when they reach school age and are ready to learn the value of savings and the basics of financial education.

Working adults could have a small portion of their paychecks, tax returns, and other government payments automatically deposited in these accounts and invested safely. People could always opt out and make withdrawals from their accounts, (with perhaps some funds locked away for special purposes such as education or retirement), but they would have to overcome the natural inertia of human nature to do so.

These policies would make savings, not consumption, the "default setting" for Americans, and they would facilitate a meaningful transition to a real "save and invest" economy.